Financial Condition Report 2017

Transcription

1 Financial Condition Report 2017

2 Contents Introduction Executive Summary Statement of Directors Responsibilities A. Business & Performance A.1 Business A.2 Performance A.3 Investment Performance A.4 Performance of other activities A.5 Other information B. System of Governance B.1 General information on the system of governance B.2 Fit and proper requirements B.3 Risk management system B.4 Internal control system B.5 Internal audit function B.6 Actuarial function B.7 Outsourcing B.8 Other information C. Risk Profile C.1 Insurance risk C.2 Market risk C.3 Credit risk C.4 Liquidity risk C.5 Operational risk C.6 Other material risks C.7 Other information Stress and sensitivity tests D. Valuation for Solvency Purposes D.1 Assets D.2 Technical provisions D.3 Any other information E. Capital Management E.1 Own funds E.2 Solvency Capital Requirement and Minimum Capital Requirement E.3 Use of Duration based equity risk submodule in the calculation of SCR E.4 Difference between Standard Formula and any Internal Model used E.5 Noncompliance with the Minimum Capital Requirement and noncompliance with the Solvency Capital Requirement Appendix: 1 Governance Map 2 SMUA Quantitative Reporting Templates 1

3 Introduction The structure of the Financial Condition Report (FCR) follows the requirements of the Bermuda Monetary Authority s Insurance (Public Disclosure) Rules 2015 and those of the Solvency II regulations. This is the first FCR that publishes the solvency positions of the Steamship regulatory group and each entity within that group as at 20 February Its purpose is to provide Members, their Brokers and other interested parties with an understanding of the risks taken by the Club and the capital that is maintained to protect against the consequences of those risks materialising. Definitions Steamship Regulators A collective term covering Steamship Mutual Underwriting Association Limited (SMUA), The Steamship Mutual Underwriting Association (Bermuda) Limited (SMUAB) and The Steamship Mutual Trust (SMUAT) subject to regulatory capital requirements, individually and collectively to the extent applicable in regulations. The Prudential Regulation Authority (PRA), the Financial Conduct Authority (FCA), the Bermuda Monetary Authority (BMA) and the European Insurance & Occupational Pensions Authority (EIOPA). Regulatory terminology Term BMA PRA / EIOPA Public disclosure document (FCR) Financial Condition Report (SFCR) Solvency & Financial Condition Report Regulatory Group Level (GSSA) Group Solvency SelfAssessment (Group ORSA) Group Own Risk and Solvency Assessment Solo entity level (CISSA) Commercial Insurers Solvency SelfAssessment (ORSA) Own Risk and Solvency Assessment Standard formula (BSCR) Bermuda Solvency Capital (SCR) Solvency Capital Requirement Requirement Minimum capital requirement (MSM) Minimum Solvency Margin (MCR) Minimum Capital Requirement Capital resources Available Statutory Capital & Surplus Own Funds 2

4 Executive Summary The Club manages its overall capital resources to maintain a financial strength rating of A from Standard & Poor s. In practice this is a higher capital requirement than is set by regulators. The Club also ensures that capital resources of individual Steamship companies are more than sufficient to meet the requirements set by local regulators. The Solvency II system of regulation came into force on 1 January Under Pillar 3 of the Solvency II regime insurers are now required to publish an annual Solvency and Financial Condition Report (SFCR) to the market. The aim of this report is to enable readers to understand the amount and type of risk taken by an insurer, as reflected in its capital requirement, and to compare this with the amount and type of capital resources which the insurer has available to protect itself against those risks. Under Solvency II Steamship Mutual is considered to be a regulatory group comprising Steamship Mutual Underwriting Association Limited, The Steamship Mutual Underwriting Association (Bermuda) Limited and The Steamship Mutual Trust. The supervisor for this group is the Bermuda Monetary Authority (BMA) and so Steamship calculates its group solvency capital requirement using the BMA s standard formula. At 20 February 2017 Steamship had a group capital requirement of US$227.3 million and total capital resources of US$610.9 million. The solvency ratio was therefore 269%. The following table shows the solvency positions of the Group and each entity in the Group. US$000 Entity Group SMUAT SMUAB SMUA Capital resources 610, , , ,508 Solvency Capital Requirement (SCR) 227, ,686 16,752 76,511 Solvency Ratio 269% 286% 689% 185% The following tables show the components of the group capital requirement and capital resources: US$000 Group Underwriting risks 292,252 Counterparty default risks 5,971 Market risks 68,264 Operational risks 26, ,483 Diversification between risk categories (166,215) Capital requirement 227,268 Consistent with the aims of a mutual insurer the majority of the capital requirement derives from underwriting risk. Market risk relates to the investments held by Steamship and reflects a conservative investment strategy. 3

5 Executive Summary US$000 Group Tier 1 capital Free reserves on Solvency II basis 504,595 Tier 2 capital Steamship Hydra Cell 34,757 Allowance for ability to make additional calls 71,535 Capital resources 610,887 Tier 1 capital refers to resources which are on the balance sheet and are generally available to meet risks throughout the business. Tier 2 capital relates to resources which are either only available to meet particular risks or are additional funds that can raised if required. Tier 2 capital can be used to make up a maximum of 50% of the SCR. Solvency II requires that combined free reserves in the financial statements of US$510.3 million be restated on an economic basis. The main adjustments required are to the provision for outstanding claims where any prudence in provisions is removed, leaving a best or most likely estimate of cost, a discount is then applied to reflect the time value of money and finally a risk margin is added using a standard calculation. The aim of this adjustment is to make claim provisions and therefore free reserves more comparable across insurers. Part of the capital held in the Steamship Hydra cell, US$34.8 million, is considered to be only available to meet risks arising in the Hydra cell and is hence classified as Tier 2. The regulator recognises that the Club can increase capital resources by making additional premium calls under its rules. Following an application to the regulator an allowance of US$71.5 million has been approved as Tier 2 capital. Outlook for 2017 The shipping market continues to be depressed with subdued economic growth and overcapacity representing major headwinds for the Club s Members. Steamship continues to perform strongly due to recent low levels of claims and improvements in the projected ultimate cost of claims on prior years. The macroeconomic background for 2017 remains challenging. As the process of the UK leaving the EU commences this year we anticipate continued uncertainty and elsewhere political instability is also likely to result in a subdued economic environment. 4

6 Statement of Directors Responsibilities Statement of Directors Responsibilities The Directors are responsible for preparing the Financial Condition Report (FCR) in accordance with the BMA s Insurance (Public Disclosure) Rules 2015, the PRA rules and Solvency II Regulations. Each of the Directors, confirms that, to the best of their knowledge: (a) throughout the financial year in question, the Group and its solo insurance undertakings have complied in all material respects with the requirements of the BMA and PRA rules and applicable Solvency II regulations; and (b) it is reasonable to believe that, at the date of the publication of the Financial Condition Report (FCR), the Group and its solo insurance undertakings continue so to comply, and will continue so to comply in future. The FCR has been authorised for issue by the Directors on 24 July By Order of the Board 5

7 A. Business & Performance A.1 Business Steamship is a mutual Protection and Indemnity Association, otherwise known as a P&I Club, which operates as a nonprofit making organisation providing cover for its shipowner and charterer Members against third party liabilities arising from the use and operation of ships. The Club covers a wide range of liabilities, including loss of life and personal injury to crew, passengers and others on board, cargo loss and damage, pollution by oil and other hazardous substances, wreck removal, collision and damage to property. The Club also provides a wide range of services to its Members (policyholders) on claims handling, legal issues and loss prevention, and plays a leading role in coordinating the response to, and management of, maritime casualties involving Members vessels. Steamship is one of the largest and most diverse P&I Clubs in the world, and is a member of the International Group of P&I Clubs participating in the International Group Pool. The thirteen principal underwriting associations which comprise the International Group collectively provide liability cover for shipowners which own approximately 90% of the world s oceangoing ships. The Group Clubs provide costeffective insurance to shipowners through a claimssharing Pool and collective purchase of the International Group excess loss reinsurance programme. These two arrangements provide a mechanism for sharing claims in excess of US$ 10 million up to, currently, approximately US$ 7.75 billion. The policy year of all P&I Clubs commences at noon Greenwich Mean Time on 20 th February. Three core agreements underpin the governance and functioning of the International Group, namely the Group Constitution, the International Group Agreement and the Pooling Agreement. More details on these agreements can be found on the International Group s website at Steamship s strategy is to be the best provider of the full range of marine protection and indemnity (P&I) and related insurances, on the mutual principle, delivering both first class service and security at a reasonable cost. Principles that underpin this strategy are: 1. advocacy of the principle of mutuality and the benefits of this for shipowners across the whole range of their insurance needs; 2. provision of technical expertise and a dedication to problem solving for the members; 3. a belief in the benefit of a diverse membership by geographical area and vessel type; 4. a prudent approach to investment policy resulting in financial security and stability; and 5. preeminence in loss prevention initiatives. Guided by a clearly defined risk appetite statement, risk management is key to Steamship s strategy: diversification of members and vessels to reduce concentration of risk; a prudent investment approach focused on stable, secure returns, constraining market risk; a focus on loss prevention initiatives aiming to limit losses to members and reduce claims; and an internal culture that is sensitive to the requirements of risk management. Steamship s strategy is to carefully grow its business organically, admitting new Members with high quality operations and a willingness to pay the premium required by the risk exposure which their business brings to Steamship. Steamship s business model is therefore to maintain a sharp focus on serving its members and to have a well diversified portfolio by trade and geographical location. 6

8 A. Business & Performance The Boards have appointed Managers who are responsible for the day to day handling of underwriting, claims and the administration of the Club s business in accordance with the policies laid down by the Directors. The Managers have operations in London, Bermuda, Hong Kong, Rio de Janeiro and Piraeus. The diagram below depicts the corporate structure which came into effect in February Managers Steamship Mutual Underwriting Association Trustees (Bermuda) Ltd (SMUAT) Reinsurance Contract (from 2015) The Steamship Mutual Underwriting Association (Bermuda) Ltd (SMUAB) Key Authorised and regulated by BMA (Bermuda) Authorised and regulated by PRA and/or FCA (UK) International Group Excess Loss Programme Reinsurance Contract Member International Group Pool Steamship Mutual Underwriting Association Ltd (SMUA) Regulatory Group supervised by BMA 7

9 A. Business & Performance Steamship Mutual Underwriting Association Limited Steamship Mutual Underwriting Association Limited (SMUA) was incorporated in the United Kingdom on 16 October 1909 and registered in England and Wales. SMUA is limited by guarantee and does not have share capital as it is owned by its Members (policyholders). The Members of SMUA comprise its Directors, SMUAB, shipowners and other entities who have ships insured by SMUA. The day to day operations of the Association are managed by Steamship P&I Management LLP (SPIM) and therefore the Association does not have any employees. The Association is governed by a Board comprising a nonexecutive Chairman, five nonexecutive directors and two members of SPIM. The Board mainly consists of representatives of the Members. The Association is regulated by the PRA and the FCA. Both the PRA and the FCA operate a riskbased approach to supervision, which places emphasis on the need for regulated firms to have in place robust risk management frameworks. The PRA is the lead supervisor for the purposes of Solvency II regulation. The Steamship Mutual Underwriting Association (Bermuda) Limited The Steamship Mutual Underwriting Association (Bermuda) Limited (SMUAB) was established by an Act of the Parliament in Bermuda on 24 June 1974 and began underwriting with effect from 20 February SMUAB is also limited by guarantee and does not have share capital as it is owned by its Members (policyholders). The members of SMUAB comprise its Directors, shipowners and all members of SMUA. The operations of the Association are managed by Steamship Mutual Management (Bermuda) Limited and therefore the Association does not have any employees. The Association is governed by a Board comprising a nonexecutive Chairman, 26 nonexecutive directors incorporating two Directors of the Manager s London representatives. The Board mainly consists of representatives of the Members. Following the February 2015 restructure SMUAB ceased writing direct business but continued to operate as a reinsurer of SMUA. The Association is supervised by the BMA and is classified as a Class 3A insurer (Solvency II equivalent). Steamship Mutual Trust The Steamship Mutual Trust and its Corporate Trustee, The Steamship Mutual Underwriting Association Trustees (Bermuda) Limited (SMUAT) were established on 11 March 1983 in Bermuda. SMUAT is a registered insurer under Bermudian law, and this enables the Trust to act as an independent insurer for the benefit of the beneficiaries set out in the Trust Deed. These are, in addition to a number of named charities, all the Members for the time being of SMUAB. SMUAT is governed by a Board comprising a nonexecutive Chairman and five nonexecutive directors including the Chairmen of SMUA and SMUAB in an exofficio capacity. The operations of the Trust are managed by Hamilton Investment Management Limited and therefore the Trust and SMUAT do not have any employees. The Trust through SMUAT is supervised by the Bermuda Monetary Authority and is classified as a Class 3A insurer (Solvency II equivalent). Each year commencing 20 February the Trust enters into a reinsurance contract with SMUAB for the reinsurance of all risks accepted. Following the implementation of Solvency II rules from 1 January 2016, the BMA became the supervisor of the regulatory group with SMUAT being named as the Designated Insurer (and hence lead insurer) for group supervision purposes. 8

10 A. Business & Performance Steamship s registered offices and principal places of business and the contact details of its external auditors and supervisory authorities are shown below: The Steamship Mutual Underwriting Association Trustees (Bermuda) Limited Registered Office Managers External Auditors Group Supervisory Authority Clarendon House 2 Church Street Hamilton HM 11 Bermuda Hamilton Investment Management Limited Washington Mall II PO Box HM 601 Hamilton HM CX Bermuda Deloitte LLP Hill House 1 Little New Street London EC4A 3TR +44 (0) Bermuda Monetary Authority BMA House 43 Victoria Street Hamilton Bermuda The Steamship Mutual Underwriting Association (Bermuda) Limited Registered Office Managers External Auditors Supervisory Authority Clarendon House 2 Church Street Hamilton HM 11 Bermuda Steamship Mutual Management (Bermuda) Limited Washington Mall II PO Box HM 601 Hamilton HM CX Bermuda Deloitte LLP Hill House 1 Little New Street London EC4A 3TR +44 (0) Bermuda Monetary Authority BMA House 43 Victoria Street Hamilton Bermuda Steamship Mutual Underwriting Association Limited Registered Office Managers External Auditors Supervisory Authority Aquatical House 39 Bell Lane London E1 7LU Steamship P&I Management LLP Aquatical House 39 Bell Lane London E1 7LU +44 (0) Managers London Representative Steamship Insurance Management Services Limited Aquatical House 39 Bell Lane London E1 7LU +44 (0) Deloitte LLP Hill House 1 Little New Street London EC4A 3TR +44 (0) Prudential Regulation Authority 20 Moorgate London EC2R 6DA +44 (0) Financial Conduct Authority 25 The North Colonnade London E14 5HS +44(0)

11 A. Business & Performance Steamship writes insurance internationally. The largest markets by premium are shown in the table below. Gross premium written by Member location US$000 US$000 United States of America 103, ,598 South Korea 21,434 25,910 Germany 18,881 24,162 Netherlands 15,752 14,617 Brazil 15,005 17,749 Hong Kong 12,337 15,377 Taiwan 11,728 13,556 Italy 11,129 11,557 Cyprus 10,179 11,410 India 9,912 11,821 United Kingdom 9,360 9,426 China 8,302 10,152 Chile 7,760 9,089 Other countries 50,614 53, , ,329 Gross premium, excluding the return of US$25.8 million, decreased by US$18.9 million or 5.4% to US$331.4 million reflecting reduced Excess Loss reinsurance premium, increased premium churn, increased lay ups and reductions in premium agreed at renewal. A.2 Performance Steamship performed very strongly for a third year in succession in 2016/17 with free reserves increasing by US$70.0 million to US$510.3 million. This follows the two previous years which saw increases of US$64 million and US$75 million respectively. The combined ratio was 83.5% which follows the two previous years combined ratios of 76% and 83% compared to a target of less than 100% on a rolling three year basis. Free Reserves (US$ Millions) 600 Combined Ratio 120% * 100% % 60% % * Net of US$26 million return of premium to members 20% 0%

12 A. Business & Performance The combined ratio gave rise to an underwriting surplus of US$41.2 million which was driven by an exceptionally low level of retained and Pool claims in the 2016/17 policy year. For the 2016/17 policy year, when compared to the preceding year, the Club experienced a similar number of claims in the layers below US$250,000 but the average cost of such claims was nearly 20% lower. Conversely the number of larger claims was even lower than was experienced last year but their average cost was similar to the average of recent policy years. Overall net estimated claims, including IBNR provision and after reinsurance recoveries, were US$188.6 million or 14.7% below the figure for the 2015/16 policy year at the same point. Prior policy years continued to develop favourably and broadly in line with the Board s expectations. More information about the performance of Steamship can be found in the Management Highlights, in particular in the Chairman of the Board s Introduction on pages 2 to 3 or in the Report & Accounts of the individual entities Renewal The Board decided that, for a third successive year, no general increase was to be applied at renewal. Including the projected value of higher deductibles and other changes in terms, premium for owned entries fell by 1.7% on a like for like basis. Tonnage The level of entered tonnage grew by 8.5%, 11.9 million gross tons at renewal, much of which came from chartered vessels, and the overall total entered tonnage rose to million gross tons (84.6 million gross tons of owned business and 66.7 million gross tons of chartered business). Capital Strength In October of this year, as part of its annual overall review of projected capital requirements and capital resources the Board will consider another return of premium to Members and the level of release calls. 11

13 A. Business & Performance A.3 Investment Performance One of Steamship s primary objectives is to have a prudent approach to investment policy in order to maintain financial security and stability. Steamship splits its investments into operational, matching and surplus portfolios. The operational portfolio is the set of bank accounts and overnight deposits maintained to meet day to day liquidity requirements. The matching portfolio is designed to match the duration and currency of best estimate claims liabilities with highly rated government and corporate bonds. The surplus portfolio is the set of investments in excess of those required for the matching portfolio and is invested to achieve a good riskadjusted return net of fees. 8% 8% 1% 26% Asset Type Corporate bonds Government bonds Cash 14% $509m 2017 $519m Absolute return funds Hedge funds of funds Equities 18% $20m 25% Property Portfolio Matching Operational Surplus The combined investment portfolio recorded an overall gain of US$31.0 million before fees, a return of 2.8%, excluding US$0.7 million of adverse currency movements which are included in the underwriting result. A 2.0% return on bonds, which form the majority of the portfolio, was supplemented by a 19.3% return on equities and an 8.5% return on hedge funds of funds. Total cash and investments increased by 1.6% to US$1.06 billion. The Trust recorded an investment gain of 4.0% compared to a loss of 0.1% in the previous year. More information about the investment performance of Steamship can be found in the Management Highlights in the Investments section on pages 38 to 39. The information presented in section A provides a true and fair view of the business and performance of Steamship during the period. 12

14 B. System of Governance B.1 General information on the system of governance Steamship has an effective system of governance in place which provides for sound and prudent management. Steamship entities are governed by a Board comprising a nonexecutive Chairman and nonexecutive directors representing the Members. The following table sets out the Board composition of each Steamship entity. SMUAT Board A L Marchisotto, Moran Holdings Inc (Chairman) J G Conyers A E Exel, Adara Advisors Pty Ltd (resigned 23 January 2017) C C Tung, Orient Overseas (International) Ltd A Pohan, NY Waterway ex officio status SM Edye, Sloman Neptun, Schiffahrts, AG ex officio status SMUAB Board SM Edye, Sloman Neptun Schiffahrts AG (Chairman) B A McAllister, McAllister Towing C J Ahrenkiel, C J Ahrenkiel Consulting Switzerland S Mehta, Essar Global A Albertini, Marfin Management SAM C K Ong, UMing Marine Transport Corp M W Bayley, Royal Caribbean International A Pohan, NY Waterway C Bouch G W F Rynsard, Steamship P&I Management LLP D S Farkas, Norwegian Cruise Line M Saeidi, Islamic Republic of Iran Shipping Line (appointed 28 March 2017) M Frith, Conyers, Dill & Pearman B K Sheth, The Great Eastern Shipping Co Ltd I Grimaldi, Grimaldi Holdings SpA B B Sinha, The Shipping Corporation of India Ltd D M Ho, Magsaysay Maritime Corp M Sloan, Carnival Corporation & plc Hu, Jingwu, China Shipowners Mutual Assurance Association (retired 10 May 2016) C Sommerhage, Columbia Shipmanagement (Germany) GmbH E Ide, Naviera Ultranav Ltda Song, Chunfeng, China Shipowners Mutual Assurance Association (appointed 28 October 2016) H M Juniel, Reederei F Laeisz GmbH (retired 10 May A L Tung, Island Navigation Corp International Ltd 2016) W J Kim, Polaris Shipping Co. Ltd A Zacchello, Seaarland Shipping Management BV C J Madinabeitia, Tradewind Tankers SL R Zagari, Augustea Group S J Martin, Steamship P&I Management LLP S Zagury, Vale (appointed 1 March 2016) SMUA Board A Pohan, NY Waterway (Chairman) C J Ahrenkiel, C J Ahrenkiel Consulting Switzerland C Bouch I Grimaldi, Grimaldi Holdings SpA H M Juniel, Reederei F Laeisz GmbH (retired 10 May 2016) C J Madinabeitia, Tradewind Tankers SL S J Martin, Steamship P&I Management LLP G W F Rynsard, Steamship P&I Management LLP A L Tung, Island Navigation Corp International Ltd (appointed 6 September 2016) 13

15 B. System of Governance The Board of Directors has the ultimate responsibility for the business operating in accordance with applicable laws and regulations. The Board decides on Steamship s strategic business plan and establishes directives and instructions, as well as ensuring that appropriate internal instructions for risk management and risk control exist. The Board continuously monitors the operations of the Club, its financial performance and stability. The Audit and Risk Committee of the Board has responsibility for the detailed review of published financial reports, liaison with the internal, external auditors and regulators. The Finance and Nominations Committee of the Board has responsibility for reviewing the fees paid to the Managers and Directors. B.2 Fit and proper requirements Steamship is committed to ensuring that all members of its Boards, the key control function holders, and other senior individuals within Steamship, behave with integrity, honesty and skill, and this commitment is documented in the Key Person policy. Steamship has processes in place to ensure that appropriate standards of fitness and propriety are met and maintained. Steamship s fit and proper requirements are: Formal qualifications, knowledge and experience within the insurance sector, other financial sectors or other relevant sectors or businesses; For control functions within Steamship that require knowledge of accounting, actuarial, corporate management, business strategy, business models, system of governance and regulatory framework have the appropriate skills; and Honesty and financial soundness based on evidence regarding character, personal behaviour and business conduct including any criminal, financial and supervisory record. The Managers maintain a governance map (see Appendix 1) which sets out how governance functions are fulfilled and devolved. This addresses the desire of BMA and EIOPA to ensure proper compliance with the requirement to devolve governance functions under Solvency II and the PRA and FCA s more detailed requirements under the Senior Insurance Managers Regime (SIMR). Where a key control function is outsourced, Steamship ensures that the outsourcing firm carries out appropriate assessments of fitness and propriety for those responsible for the provision of the function and provides evidence of this. In addition, the Board s Finance and Nomination Committee regularly reviews the structure, size and composition of the Board, including skills, knowledge and experience, and makes recommendations to the Board with regard to any changes. When a new appointment is required, the Finance and Nominations Committee evaluates the balance of knowledge, skills and experience of the Board members and uses this evaluation to inform the selection of a suitable candidate. Records are maintained, and notifications made to the regulators, as and when required. B.3 Risk management system (Including the GSSA) The objective of Steamship s risk management system is to ensure that the business is carried out within the overall risk appetite set by the Board. The system is characterised by a holistic, integrated and top down driven enterprise risk management system, based on a shared risk culture. Any consideration of culture at Steamship must begin with the understanding that it is an organisation owned by its members and run for its members. This distinguishes P&I Clubs from nonmutual insurers and is a major factor in Steamship s strategic thinking and decisionmaking, in turn reflected in its handling of matters ranging from premium setting and return of capital to the consideration of claims outside the standard rules of cover. 14

16 B. System of Governance The risk management system is executed through the risk management control cycle, which involves the systematic identification, valuation, monitoring and reporting of existing and emerging risks. The risk management function is responsible for monitoring Steamship s risk management system reporting to the Executive Chairman. Steamship uses the three lines of defence assurance model which segregates business operations from oversight and monitoring activity to improve independence and assurance over business processes. First line of defence Second line of defence Third line of defence Business Operations Underwriting, Claims, Human Resources, Finance, Statistics (Pricing) Risk Compliance Statistics (Actuarial) Internal Audit The first line of defence is carried out by the operational functions. The second and third lines of defence are independent of the operational functions. Risk and compliance, together with the Actuarial & Statistics function jointly constitute the second line of defence. The third line of defence is the Internal Audit. This function is fully independent and appointed by the Board. Risk owners selfassess risk ratings and the quality of underlying controls before Risk Management undertake independent design and operational effectiveness testing. Risk profiles are considered on an inherent and residual (after controls) basis and are documented within Steamship s risk register, with aligned controls and risk categories for capital purposes. Steamship s risk profile draws on risk tolerance and trigger metrics; risk events; recommendations from internal and external sources; emerging risks & market developments; and current controls and mitigation techniques and their effectiveness. There is a high level of expertise and experience on the Board. In the course of Board meetings which generally take place over extended periods of 3 to 4 days three times a year, directors are able to bring their considerable industry knowledge and experience to bear on a range of both strategic and operational issues. Steamship s Managers are insurance professionals who engage on a daytoday basis with market and regulatory developments that may affect either the Club s insurance activity or the wider maritime community whose liability risks it underwrites. Together, Directors and Managers are either members of or attendees at meetings of the Board s key decisionmaking bodies whose deliberations inform the current and forwardlooking risk profile of the Club. The strategic business plan, risk strategy, risk appetite statement and tolerance & triggers report are integral components of Steamship s Risk Management System and are reviewed at least once a year. In this way Steamship ensures that the risk management system is kept up to date. Group Solvency SelfAssessment (GSSA) Steamship monitors and manages the risks relating to its operations through its fully documented risk management programme which analyses exposures by degree and magnitude of risks. This is evidenced in the Group Solvency Self Assessment GSSA report. The GSSA has been carried out in accordance with the ORSA policy agreed by the Board in September The Policy states that the GSSA is performed at least annually (at the October Board meeting) when the Board considers the future capital requirements, capital levels and the standard increase. The GSSA will be undertaken more frequently if specific conditions, which are set out in the Policy, are met. The Board has overall responsibility for the GSSA. 15

17 B. System of Governance The ORSA policy defines the steps that make up the overall ORSA process, which are summarized in the Chart below. The Risk management and ORSA policies include a description of each process and an explanation as to how each has been completed in order to fulfil the objectives of the ORSA as a whole. 16

18 B. System of Governance The fourth GSSA was carried out in October 2016 and documents Steamship s risk and capital management processes employed to identify, assess, manage and report the risks it may face and to determine the capital resources required to ensure that its overall solvency needs are met at all times. The GSSA is an integral part of Steamship s business strategy, explaining how the strategy aligns to risk appetite and the current risk profile. The GSSA includes both the economic capital position of the Group and the entity regulatory capital positions by reference to the Solvency Capital Requirement (SCR) and the Minimum Margin of Solvency (MMS) for the next five years. To assist in this process Steamship has developed its own fully integrated financial capital model for the purpose of quantifying its own risks. The internal capital model uses stochastic simulations to generate financial projections which are calibrated to Steamship s own historical outcomes and relevant International Group and external data. Steamship uses an Economic Scenario Generator (ESG) for the calculation of market risk. The ESG is a simulation model that produces arbitragefree economic scenarios. These scenarios include a variety of key variables, such as interest rates, credit spreads, equity and property returns and, foreign exchange rates. B.4 Internal control system The internal control system is designed to provide reasonable assurance regarding the proper implementation of Steamship s business strategy and the achievement of operational and financial strategic objectives through: monitoring and control of all risks, particularly key risks and the relevant internal controls; and robust, proportionate compliance. The internal controls are documented in Steamship s Internal Control Policy, which sets out the detailed processes for all aspects of the management of Steamship on a day to day basis. Compliance function The compliance function consists of a Group Head of Compliance, Risk and Compliance Director and a compliance executive. The compliance function is responsible for providing general oversight of control effectiveness through the administration of an Internal Controls review programme and the provision of remedial advice and to monitor relevant legislation and changes in existing rules and regulations. Risk Management function The risk management function is responsible for: identifying, managing, monitoring and reporting on current and emerging risks; setting the overall risk management and strategic framework; and monitoring and assisting in the effective operation of Steamship s risk management framework and maintaining an accurate view of Steamship s risk profile. The Risk and Compliance Director acts as Chief Risk Officer to Steamship, assisted by risk management executive, manages the day to day risk monitoring, with the Chief Finance Officer and the Director of Capital Management reporting to the Board. B.5 Internal audit function Steamship s Internal Audit function is outsourced to Moore Stephens. The function independently develops an internal audit plan based on its perception of risks to Steamship after consultation with Directors, Managers and the Risk Register. The scope of the plan is reviewed and approved by the Audit and Risk Committee. The segregation of Internal Audit s activities ensures independence and objectivity in the work that it undertakes. 17

19 B. System of Governance B.6 Actuarial function The actuarial function consists of a team of three including the Statistics Director who fulfills the function for SMUA as Chief Actuary. The Designated Actuary for the Group, SMUAB and SMUAT is fulfilled by Moore Stephens LLP. The Actuarial Function resides in the Statistics Department of SIMSL and is responsible for the calculation of technical provisions (for both the financial reporting and for solvency calculations), maintaining Steamship s Business Plan, the maintenance of the Steamship s internal capital model and aids the effective running of the risk management system, production of the GSSA, and the opinions on underwriting policy and the adequacy of reinsurance arrangements. B.7 Outsourcing Steamship has an outsourcing policy in place which is approved by the Board. The outsourcing policy ensures that outsourcing of critical or important functions or activities does not lead to any of the following: an undue increase in the operational risk; an impairment in the quality of Steamship s systems of governance; difficulties for supervisory authorities in monitoring compliance; and a deterioration in service to Members (policyholders) Management assesses whether a function or activity is critical or important and reports to the Board whenever outsourcing of a critical or important function or activity is considered and also when an agreement has been entered into. Steamship has identified four functions that are deemed Critical and Important for Solvency II purposes. These are: 1. Management services provided by Steamship P&I Management LLP (SPIM), FCA FRN (SPIM is the management company of the Steamship regulatory group entities covered by this document, which are SPIM s sole clients, so that SPIM s risks and controls are largely synonymous with those of Steamship); 2. Information Technology services provided by Timico Ltd; 3. Internal Audit services provided by Moore Stephens LLP; and 4. Underwriting activities on the Club s behalf by Post & Co, a Rotterdambased broker, concerning the European Inland and Short Sea insurance Facility. B.8 Other information There have been no material changes in the system of governance during the year, and Steamship believes it remains appropriate taking into account the nature, scale and complexity of the risk inherent in the business. In particular, the centralised approach reflects the highly integrated and interdependent nature of Steamship s activities. 18

20 C. Risk Profile Steamship monitors and manages the risks relating to its operations through its risk management programme which analyses exposures by degree and magnitude of risk. This is evidenced in the Group Solvency SelfAssessment ( GSSA ) report. The GSSA documents Steamship s risk and capital management processes employed to identify, assess, manage and report the risks it may face and to determine the capital resources required to ensure that its overall solvency needs are met at all times. The GSSA considers the business strategy, how the strategy aligns to risk appetite and the current risk profile. The principal risks faced by Steamship are insurance risk, market risk, credit risk, liquidity risk and operational risk. C.1 Insurance risk Insurance risk is comprised of two elements; premium risk and reserving risk. Premium risk refers to the risk that insurance premium written in the current policy year is insufficient to cover claims and other costs arising in that year. It thus relates to the future, whereas reserving risk is the risk that, over the next year, existing technical provisions are insufficient to cover claims arising in previous policy years. Steamship is exposed to the uncertainty surrounding the timing, frequency and severity of claims made under its insurance contracts. Premium is set using assumptions which have regard to trends and the past experience of a specific Member. Premium risk is mitigated by diversification across a variety of ship types and geographical areas, and by careful selection and implementation of underwriting strategy guidelines including the screening of new Members. Steamship transfers a substantial portion of its premium risk to its reinsurers through the provisions of the reinsurance arrangements and its membership of the International Group (Layers of the 2017/18 Reinsurance Programme). 19

21 C. Risk Profile The key methods used to estimate claims liabilities are BornhuetterFerguson for the most recent policy year reported and the development factor method for all other policy years. Reserves for both reported and unreported claims are calculated using detailed statistical analysis of the past experience as to frequency and average cost of claims. The Audit and Risk Committee compares the proposed claim reserves with an independent calculation performed by qualified actuaries at year end. Steamship aims to reduce reserving risk by setting claims reserves at a prudent level that provides between 70% and 80% confidence that they will be sufficient to cover actual settlement costs. Actual experience will differ from the expected outcome but this prudent basis is expected to result in releases of prior year claim reserves. C.2 Market risk Market risk is the risk of financial loss as a consequence of movements in the prices of equities and bonds, interest rates, currency exchange rates and other price changes. Market risk arises primarily from investment activities. Steamship s exposure to changes in interest rates and market prices is concentrated in the investment portfolio. The risk appetite, asset allocation and tolerance ranges are set by the SMUAT Board having consulted with the Boards of SMUAB and SMUA. Exposures and compliance with Board policies are monitored and reported by the Managers assisted by independent investment consultants. Steamship receives the majority of its premium income in US dollars, a significant amount in euro and small amounts in UK sterling and Canadian dollars. Claims liabilities arise in a number of currencies but predominantly in US dollars, euro, UK sterling and Brazilian reals. This exposure is mitigated by holding investments and derivatives in these currencies. To minimise currency translation costs operational bank balances in local currencies are maintained to fund expected shortterm claim payments in those currencies. C.3 Credit risk Credit risk is the risk that a counterparty owing money to Steamship may default causing a debt to be written off. The reinsurance protection arranged by Steamship effectively transforms a proportion of insurance risk into credit risk as the exposure becomes the risk of reinsurer default. External reinsurers are generally only used if their financial strength rating is at Standard & Poor s A (or an equivalent rating from another rating agency) except in the case of some members of the International Group and participants on reinsurance contracts placed through the International Group. The key areas of exposure to credit risk for Steamship are in relation to its reinsurance recoveries and bonds in the investment portfolio. Credit risk in respect of amounts due from Members is spread across diverse industries and geographical areas. Cover can be cancelled and claims set off against unpaid premium and there are other strong incentives for Members to keep their insurance cover in place. Therefore in practice the impact of late premium payment and bad debt is immaterial. Credit risk arises on operational balances and deposits held with banks. Controls include the use of a variety of banks and the limitation of individual exposures to US$10 million (S&P AA rated banks, or equivalent rating from other agencies), and US$5 million (S&P A rated banks, equivalent rating from other agencies). The one exception is an unrated, privately capitalised bank which is monitored by reference to a specific capital ratio. C.4 Liquidity risk Liquidity risk is the risk that Steamship cannot meet its financial obligations as they fall due. Steamship maintains a highly liquid portfolio of cash, government and corporate bonds with a maturity equivalent to the expected settlement period of claim liabilities. Most of the remaining assets in the surplus portfolio could be converted into cash in less than one month. C.5 Operational risk Operational risk includes fraud, interruptions in service due to external or internal disruption and procedural or systems errors. Steamship has identified its operational risks in a risk register and has in place appropriate controls to manage and mitigate such risks, consistent with good practice, regulatory guidance and legislation relating to human resources, financial crime, business continuity and information security. Appropriate controls are also in place to monitor the outsourcing of operations to the Managers and, through them, other service providers. 20

22 C. Risk Profile C.6 Other material risks Steamship s Standard Formula Appropriateness Assessment identified the obligation to fund the SIMSL (Managers) defined benefit pension scheme was not being captured by the Standard Formula. As a result the operational risk incorporates a capital addon of US$ million for this risk as agreed with the PRA. C.7 Other information Stress and sensitivity tests Steamship has developed a suite of stress and sensitivity tests, including reverse stress tests, which are used to measure the robustness of the capital position. 21

23 D. Valuation for Solvency Purposes D.1 Assets In accordance with the BMA rules and of the Solvency II Directive, Steamship s assets and liabilities (other than technical provisions) are measured in accordance with principles of an arm length transaction between knowledgeable willing parties using market consistent valuation methods. The following tables display the GAAP Balance Sheet as reported within the published report and accounts, the Solvency II adjustments made and the Solvency II valuation for the Group, SMUAT, SMUAB and SMUA. Group Assets 2017 GAAP US$000 Adjustments 2017 Solvency II US$000 Deferred acquisition costs 253 (253) Investments 1,036,263 (64) 1,036,199 Reinsurers' share of technical provisions 202,829 6, ,578 Insurance & intermediaries receivables 25,665 (6,845) 18,820 Receivables (trade, not insurance) 4,547 4,547 Cash and cash equivalents 24,554 24,554 Any other assets, not elsewhere shown 7,884 7,884 Total assets 1,301,995 (413) 1,301,582 Liabilities Technical provisions Technical provisions calculated as a whole 767,097 Best Estimate (70,204) 696,893 Risk margin 42,977 42,977 Subtotal 767,097 (27,227) 739,870 Insurance & intermediaries payables 10,688 (6,168) 4,520 Reinsurance payables 6,843 6,843 Payables (trade, not insurance) 7,000 7,000 Any other liabilities, not elsewhere shown Total liabilities 791,705 (33,395) 758,310 Free reserves 510,290 32, ,272 SMUAT Assets 2017 GAAP US$000 Adjustments 2017 Solvency II US$000 Investments 820, ,914 Reinsurers' share of technical provisions Insurance & intermediaries receivables 1,659 1,659 Receivables (trade, not insurance) Cash and cash equivalents Any other assets, not elsewhere shown 4,038 4,038 Total assets 826, ,611 22

24 D. Valuation for Solvency Purposes Liabilities Technical provisions Technical provisions calculated as a whole 486,023 Best Estimate (68,441) 417,582 Risk margin 20,904 20,904 Subtotal 486,023 (47,537) 438,486 Reinsurance payables 59,237 59,237 Payables (trade, not insurance) Total liabilities 546,197 (47,537) 498,660 Free reserves 280,414 47, ,951 SMUAB Assets 2017 GAAP US$000 Adjustments 2017 Solvency II US$000 Investments 139, ,816 Reinsurers' share of technical provisions 245,724 (37,328) 208,396 Insurance & intermediaries receivables 21,014 21,014 Receivables (trade, not insurance) 2,538 2,538 Cash and cash equivalents 3,524 3,524 Any other assets, not elsewhere shown Total assets 412,844 (37,328) 375,516 Liabilities Technical provisions Technical provisions calculated as a whole 295,171 Best Estimate (39,967) 255,204 Risk margin 3,201 3,201 Subtotal 295,171 (36,766) 258,405 Reinsurance payables 1,659 1,659 Payables (trade, not insurance) Total liabilities 296,888 (36,766) 260,122 Free reserves 115,956 (562) 115,394 23

25 D. Valuation for Solvency Purposes SMUA Assets 2017 GAAP US$000 Adjustments 2017 Solvency II US$000 Deferred acquisition costs 253 (253) Investments 75,534 (64) 75,470 Reinsurers' share of technical provisions 738,298 (74,142) 664,156 Insurance & intermediaries receivables 84,902 (6,845) 78,057 Receivables (trade, not insurance) 2,009 2,009 Cash and cash equivalents 21,030 21,030 Any other assets, not elsewhere shown 3,618 3,618 Total assets 925,644 (81,304) 844,340 Liabilities Technical provisions Technical provisions calculated as a whole 767,097 Best Estimate (78,560) 688,537 Risk margin 14,093 14,093 Subtotal 767,097 (64,467) 702,630 Insurance & intermediaries payables 10,688 10,688 Reinsurance payables 27,857 (6,168) 21,689 Payables (trade, not insurance) 6,004 6,004 Any other liabilities, not elsewhere shown Total liabilities 811,723 (70,635) 741,088 Free reserves 113,921 (10,669) 103,252 The investments are valued for Solvency II purposes on the same basis as the annual financial statements, which follow UK GAAP, except for a minor difference in the valuation of forward currency contracts. The reinsurance recoverables have, for Solvency II purposes, been discounted using the risk free rate term structure. D.2 Technical Provisions The key change under Solvency II is the economic valuation of technical provisions, comprising: the best estimate of all cashflows, positive and negative, discounted to reflect the time value of money; provisions at market value (hence, a risk margin must be added reflecting the cost of the capital tied up in running the liabilities); inclusion of legally bound contracts (even if not yet incepted); and all future outcomes (including events not in [historical] data or ENIDs have to be considered). Reconciliation of Technical Provisions Below is a reconciliation of technical provisions reported in the published report and accounts and on a Solvency II basis for the Group, SMUAT, SMUAB and SMUA. 24